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Dollar slips on tame inflation

The Australian dollar took a small hit after a surprisingly benign inflation reading suggested there was still plenty of scope for further interest rate cuts, though investors still doubt a move will come next month.

The dollar eased a third of a cent to $US1.0527 after key measures of underlying inflation rose by less than expected to be in the lower half of the Reserve Bank of Australia's (RBA) target of 2 to 3 per cent.

The data prompted a gentle move in Australian debt futures with swap markets implying a 36 per cent chance of a quarter point easing to 2.75 per cent at the RBA's next policy meeting on February 5, from 33 per cent. Yet, they still see rates bottoming around 2.5 per cent sometime this year.

"While the weaker inflation profile in the coming quarters provides the RBA with the option to cut rates, we believe a cut is unlikely at the February meeting," said Martin Whetton, a rate strategist at Nomura in Sydney.

"We have seen an improvement in the international backdrop while the domestic economy has not deteriorated meaningfully."

The central bank cut rates by 125 basis points last year as a slowdown in world growth and falling export prices darkened the economic outlook.

Yet, the world background has brightened in recent weeks, with the Chinese economy seemingly turning a corner and a recovery in prices of iron ore, Australia's top export earner, lessening the urgency for another easing in domestic policy.

Australian government bond futures also extended gains, with the three-year bond contract 0.04 points higher at 97.270, and the 10-year contract rising 0.035 points to 96.700. Both contracts hit multi-month lows earlier this month.

The Aussie dollar was also weighed by selling in euro and yen crosses. The single currency bounced back to $1.2604 from an overnight trough of $1.2560 hit when investors opted to book profit following hefty gains.

The dollar was nursing losses against a firmer yen, falling 0.4 per cent on the day to 93.59 yen, well off Tuesday's high of 94.87 yen struck immediately after the Bank of Japan's latest move to spur its economy yesterday.

Still, the currency is up more than 13 per cent on the yen since November with analysts expecting the rise to continue given the Japanese government's determination to fight deflation.